Monday, February 3, 2014

Tax Tip: Home Office Deduction

Many artisans and Etsians have a dedicated work space in their homes -- a studio, workshop, or office.
If that space is used exclusively for business on a regular basis, you may be entitled to a tax deduction for costs associated with that space.

Historically, those expenses were claimed on a Form 8829-Expenses for Business Use of Your Home.
But beginning this tax season (Tax Year 2013), you may be able to use a SIMPLIFIED OPTION when figuring the deduction.

So what makes the simplified option so simple?

Easy math.  Determine the square footage of your studio, office, etc.   Let's say it is a 12' x 10' room.
That's 120 square feet.  Multiply 120 x $5.00 / square foot, and your deduction is $600.00.

Less record keeping required.  Using the simplified method, you no longer need to keep all your utility bills, house insurance statements, etc., in order to support your office in home deduction.  The $5.00 is a rough approximation of all those expenses that the IRS will accept without further documentation.

House-related deductions stay on Schedule A.  If you itemize deductions (Schedule A), you can deduct home mortgage interest, real estate taxes, and private mortgage insurance for mortgages originated in 2007 or later.  

Under the old method (Form 8829), all of those expenses had to be allocated based on a ratio equal to:

Square Footage of Studio or Home Office
Square Footage of House

So, if your whole house is 2400 square feet, but your office is only 120 square feet, you would have claimed 95% of mortgage interest, real estate taxes and PMI on Schedule A, and 5% on Form 8829.

Under the simplified method, you can take 100% of those house-related deductions on Schedule A -- no allocation required.  Much simpler.

No Depreciation to calculate.  Historically, if you used Form 8829, you would elect to depreciate that portion of the home that was used for business over many years.  If you sold the home, however, you would be required to "recapture" the prior depreciation deductions claimed.    Under the simplified method, there is no depreciation deduction for the home.  NOTE: You can still depreciate equipment, furniture, etc. used in the office on Schedule C - Profit and Loss from Business.  You just can't depreciate the value of the office space itself.

Why would anyone NOT use the simplified method?

300 Square Foot ($1500) Limit:   The simplified method is limited to 300 square feet or $1500, so if you have a REALLY BIG studio (I'm thinking of you, Edi and Sher), you might be better off keeping the records and using the more detailed Form 8829.

Depreciation Can Be a GOOD Thing:  Even though you might have to recapture some depreciation if you sell your home, you will get a nice-sized annual deduction for depreciation if you use the regular method.  Let's say your home is valued at $300,000.00 (excluding land value).  The value of the depreciable 5% (using the example above) would be $15,000.00.   Your yearly home office depreciation deduction would be a few hundred dollars per year -- not chump change!

Carry Over Losses:   If the gross income from your business (less business expenses) is less than the home office deduction computed on Form 8829, you can carry over the unused loss to use in another tax year.  It's not lost forever. Under the simplified method,  there's no carryover.  If you can't use your whole home office deduction because of the income limitation, you lose it.  Too bad.  So sad.

For a more detailed discussion, see IRS Rev. Proc. 2013-13, or this IRS Tax Topics summary.

Thanks for stopping by.


  1. Great post on the home office deduction! :)

  2. I'm too scared of being audited to use it. But, thanks for the explanation.

    1. I don't claim it either, because I don't use my sewing room exclusively for business.

  3. Great tips! I'll have to mention this to my tax preparer for 2013. I know I'll need to make changes for this year, but it might work out well for last year.

    1. Yes. And if you elect the simplified method this year, you can still do the "long form" for home office expenses next year.

  4. I always loved getting the deduction for having a home studio. :-) Thanks for explaining the new option!

  5. As always, great tips! Tax time is so scary for me because I'm afraid I'll make a mistake.

    1. If it's an honest mistake, they can't send you to Leavenworth. It is a bit daunting when you only deal with it once a year. So many changes.